* Investors pour money back into drugmakers, consumer stocks
* Full-blown trade war seen further lifting defensives
* Markets could be turbulent when U.S. decides on tariffs
* Graphic on defensives vs cyclicals: reut.rs/2OjVwBQ
By Danilo Masoni
MILAN, Aug 9 (Reuters) - The risk of trade barriers and slowing global business activity has kept the European equity market in check this year.
That, however, has been a boon for shares in companies such as drug-makers and consumer staples that are less dependent on the economic cycle and which investors say could provide a shelter should trade tensions between Washington and Beijing blow up.
After over a year of neglect, fund managers began in the second quarter to pour money back into firms such as yoghurt maker Danone, food giant Nestle, drugmakers Novartis and Roche, as well as tobacco giant BAT and the maker of Durex condoms Reckitt Benckiser .
In some cases they have turned a blind eye to challenges facing some of these companies because their compelling valuations and resilience to any trade-related economic downturn was an incentive to re-engage. Morgan Stanley estimates a full-blown trade war would wipe 0.8 percentage points off global GDP growth.
"We are slightly more invested in defensive sectors also in relation to the risk of a trade war," said Jerome Schupp, fund manager at Geneva-based investment firm Prime Partners.
He said his firm had bought Danone shares a few months ago and had some drugmakers as strategic assets. He added that they had invested in these companies, betting on their growth potential and not purely because they are defensive.
Europe's equity market is barely in the black in 2018 but while sectors such as autos, which are highly dependent on global trade, have been a drag, defensives have filled the gap.
The move started when U.S. President Donald Trump said in March he would introduce import tariffs on steel and aluminium, stoking fears of a global trade war. It then continued at the start of the summer in the run-up to a series of key deadlines for the United States to decide on planned protectionist moves.
"Investors in European equity have become familiar with the theme of a return of leadership of defensive stocks," wrote Kepler Cheuvreux strategist Christopher Potts last week when he upgraded European personal & household sector to overweight.
A key date on investors' radars is Sept. 5 when a comment period on Trump's plan to tax $200 billion of Chinese imports expires, paving the way for a decision in the following weeks. Analysts also expect Washington to decide on possible auto import tariffs in October.
These deadlines are fuelling expectations there will be no exception this year to August being a traditionally turbulent month for markets. "The defensive bias should remain apparent through August into September," Potts said.
"HIGH-PROFILE POKER GAME"
Defensives have been a very popular trade during the long years of easy monetary policy in Europe that squeezed rates to zero, boosting their appeal as cash flow machines paying steady dividends to their shareholders.
But when in the second half of 2016 an economic recovery in Europe gathered pace, defensives started to lose ground to stocks more tied to the business cycle. Their decline continued throughout the "euroboom" year of 2017 but the tide appeared to turn once again when Trump kicked off the trade war.
Much of how the revival will pan out will depend on whether the United States and China will be able to find an agreement or there is a trade war escalation.
"Is Trump just playing this very clever high-profile poker game with the Chinese. Will he back down and reach some sort of compromise?" said David Hussey, portfolio manager at Manulife Asset Management. He said stocks like Reckitt - which he described as a "textbook example" of the fortunes of income paying companies - or tobacco firms were "interesting" investments earlier this year because of cheap valuations.
"They've (tobacco firms) been awful performers for a variety of reasons. But when you get to valuations which ... assume the business disappears in 10 to 12 years, that's just not realistic," he said.
The defensive stocks' rally this year has filled a valuation gap versus cyclicals and fund managers such as Hussey and Schupp but also Federico Trabucco at Kairos Parnters in Milan say they are ready to tweak their holdings in turbulent markets.
Some strategists recommend that clients keep some extra cash ready. While defensives have legs to gain further in a less valuation-oriented move, a big rebound in cyclicals cannot be ruled out, depending on the trade talks' outcome.
Beyond the tariff noise, however, the global economy continues to tick along well and corporate earnings growth is stellar in the United States and strong in Europe.
"I've lifted my exposure to defensives as a tactical move. But if the trade clouds clear in September/October, you must be ready to turn around your portfolio," said Trabucco.
Reporting by Danilo Masoni; Editing by Alison Williams